thewonderjam

Mike Albert

Why Gross Margin is Actually Sexy

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Whether you know it or not, gross margin can make or break your small business.

So what is it? Essentially, gross margin is what’s left of the company’s revenue after accounting for direct costs. As the name implies, direct costs are those directly associated with producing your goods or services for sale.

The calculation isn’t complicated; Revenue — Direct Costs = Gross Margin.

Example: Mr. West is the greatest artist of our generation. He produces a t-shirt that sells for $120 per unit. The direct costs include the blank t-shirt ($5.00), the cost of supplies to silkscreen the t-shirt ($0.50) and the labor to apply the silkscreen ($0.50).

The gross margin for each t-shirt Mr. West sells is $114.00.

So why is it important to track your gross margin?

One important reason is that knowing how much gross margin each unit generates allows you to easily and accurately calculate your break-even unit sales target for a given time period. By dividing your indirect costs by the gross margin generated from each sale, you can estimate how many units you need to sell to break even. Indirect costs, also known as overhead, are all expenses not associated with producing your product or service. Some examples of indirect costs are rent, insurance, electricity, and administrative payroll.

The calculation to do this is: Indirect Costs / Gross Margin = Break-Even Unit Sales

Example: Assuming Mr. West has indirect costs that total $10,000 per month, he would need to sell 87.7 of his t-shirts to break even for the month.

You can see that Mr. West’s strong margins make it easy for him to cover his high overhead.

Another key reason to track your margins is so that you can evaluate the strength of your margins against others in your industry. A simple google search of “gross margin averages for (insert industry name here)” will give you a good starting point for establishing benchmarks to compare against. If your gross margins fall below your industry average, consider increasing the price of your product and/or figuring out how to lower your costs. This will strengthen your margins, and require you to sell fewer units to make a profit.

To illustrate the difference strong margins can make, see the contrasting example below.

Example: Mr. North is not the greatest artist of our generation and he sells his t-shirts for $20. His direct costs are also $6.00 per unit. His gross margin is only $14 per unit, rather than the $114 Mr. West generates. Mr. North would need to sell over 714 units to break even, whereas Mr. West only needs to sell about 88; that’s about 8x the number of units!

So what should you do next?

Break out your financials, calculate your gross margins and units required to break even. Then compare those figures to your industry averages. If you need to strengthen your margins, go back to the drawing board. Reconsider your price; is it too low? Leave no stone unturned when looking for direct cost savings. As you can see, every penny of margin matters.

Have questions? Leave them in the comments!

Objectives and Key Results

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If you read my last blog, where I discussed defining your win, you may be asking, what’s next? In order to effectively navigate from where you are today to your ultimate goal, you’ll need a systematic way of prioritizing your efforts. This is where I introduce the concept of Objectives and Key Results (OKRs).

OKRs are a management methodology that help to ensure everyone in an organization focuses their efforts on the most important issues. Some of the most successful companies in the world are using OKRs as a management methodology, including Amazon, Facebook, Google, GoPro, Slack, Spotify and many more.

THE BASICS

Objectives

What you want to accomplish. These should be the most important things that the company wants to accomplish over the time period. They are significant and aspirational. They communicate action and must be supported by the entire organization. Example: SpaceX will send a man to Mars.

Key Results

How you will accomplish your objectives. These are specific, actionable, and reportable. They need to be clearly measurable and need to have a specific deadline. Example: SpaceX will build a lunar module weighing under 40,000 pounds by the end of the year.

NEXT STEPS

The next steps would be set the time period for your Objective cycles. Most established companies set Objectives every quarter. For newer companies whose innovation cycle is much faster, I recommend setting Objectives monthly.

Once time periods are established, work with your team to develop Objectives that are aggressive and advance the organization toward your end goal. It’s vital to get input from your team and a best practice for OKRs is that 50% of the Objectives should come from the bottom up. The organization should set 4–5 Objectives for the time period with 3–4 Key Results per Objective. Each division of the organization should have a stake in delivering results to move the Objectives forward.

It’s important that each Key Result has a measurable attached to it, so that progress can be easily reported throughout the time period. This ensures that everyone in the organization knows the exact status of each OKR at any time. Key Results should be regularly reported. At the end of the time period, repeat the process of setting OKRs that advance the organization toward their win.

If you have any questions or comments, leave them below!

Define Your Win

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In this scene of ‘Alice in Wonderland’, Alice is seeking direction from the Cheshire cat. I think we’ve all felt this way, at some point.

Alice: Would you tell me, please, which way I ought to go from here?

The Cheshire Cat: That depends a good deal on where you want to get to.

Alice: I don’t much care where.

The Cheshire Cat: Then it doesn’t much matter which way you go.

A lot of times, running a business can leave you feeling lost and directionless, but it doesn’t have to be that way.

Whether you’re a startup or you’ve been in business for years, defining the end goal of your business is one the most critical steps in building the business and life that you want. I call it, defining your win, and it’s one of the first exercises I cover with new clients.

Seems simple enough, right? Certainly, anyone who has jumped through the dozens of hoops to start a business, begins with a clear vision of the future. Unfortunately, it’s not as common as it should be.

Whether you’re just getting started or you’re a veteran business owner, investing the time to get clear about what you want is very smart. Figuring out what you want requires introspection and doesn’t always come easy so don’t get discouraged. Keep working at it until you’re confident that you’ve defined your win. Here are a few questions to help you get started:

  • Why am I starting a business?
  • What are the things I want to spend my time doing once my business is in its end state?
  • What are the things I don’t want to spend my time doing?
  • How much money do I want/need to make and when do I expect to hit that mark?
  • Do I want to manage employees? If so, how many?
  • What will the balance of my personal/family time and work time be?
  • Do I want to run my business indefinitely, or am I building it to sell it?

Once you get clear about what you want, it allows you to be disciplined and intentional about how you build your business. Decision making becomes easier, leadership becomes consistent, the roadmap becomes clear. Again, step one is knowing where you’re going. Step two through two million are how you get there.

Give it a shot, and if you have questions or comments leave them below!